##### Table of Contents



UNITED STATESSECURITIES
 AND EXCHANGE COMMISSION

Washington D.C. 20549

FORM 10-Q



|[X] | QUARTERLY
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|--- | ----------------------------------------------------------------------------------------

For the quarterly period ended September
 30, 2002

OR



|[  ] | TRANSITION
 REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|---- | -----------------------------------------------------------------------------------------

For the transition period from _______________to _______________

Commission File Number 1-12607



|SUNLINK HEALTH SYSTEMS,
 INC.                          
|-------------------------------------------------------
|                                                       
|(Exact name of registrant
 as specified in its charter)



|Ohio                                           | 31-0621189          
|---------------------------------------------- | --------------------
|                                               |                     
|(State
 or other jurisdiction of incorporation | (I.R.S.
 Employer   
|or organization)                               | Identification
 No.)



|900 Circle 75 Parkway,
 Suite 1300, Atlanta, Georgia 30339
|----------------------------------------------------------
|                                                          
|(Address of principal executive offices)
(Zip Code)       



|(770) 933-7000                                       
|-----------------------------------------------------
|                                                     
|(Registrants
 telephone number, including area code)

Indicate by
 check mark whether the registrant (1) has filed all reports required to be filed
 by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
 12 months (or for such shorter period that the registrant was required to file such
 reports), and (2) has been subject to such filings requirements for the past 90
 days.

Yes [X]     No [  ]

The number
 of Common Shares, without par value, outstanding as of November 8, 2002 was 4,997,592.





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TABLE OF CONTENTS



|                                                |                                                                                               |                                                      |  |  |  |  |  | 
|----------------------------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I. FINANCIAL INFORMATION                  
|                                                | ITEM 1. FINANCIAL STATEMENTS                                                                 
|                                                |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                                                |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS       
|                                                |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                                                | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                           
|                                                | ITEM 4. EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES                                     
|PART II. OTHER INFORMATION                     
|                                                | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                     
|EX-10.1 AMENDED & RESTATED EMPLOYMENT AGREEMENT
|EX-10.2 AMENDED & RESTATED EMPLOYMENT AGREEMENT
|EX-10.3 AMENDED & RESTATED EMPLOYMENT AGREEMENT
|EX-10.4 LOAN AGREEMENT                         
|EX-10.5 CONTRACT OF GUARANTY                   
|EX-99.1 SECTION 906 CERTIFICATION OF THE CEO   
|EX-99.2 SECTION 906 CERTIFICATION OF THE CFO   



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PART I. FINANCIAL INFORMATION





ITEM 1. FINANCIAL STATEMENTS







|SUNLINK HEALTH SYSTEMS, INC. AND
 SUBSIDIARIESCONDENSED CONSOLIDATED BALANCE SHEETS
|-----------------------------------------------------------------------------------
|(in thousands)                                                                     
|(unaudited)                                                                        
|                                                                                   
|                                                                                   
|                                                                                   
|ASSETS                                                                             
|Current Assets:                                                                    
|Cash and cash equivalents                                                          
|Receivables - net                                                                  
|Medical supplies                                                                   
|Prepaid expenses and other                                                         
|                                                                                   
|Total Current Assets                                                               
|Property, Plant and Equipment, At Cost                                             
|Less accumulated depreciation and amortization                                     
|                                                                                   
|Property, Plant and Equipment - Net                                                
|Other Assets                                                                       
|                                                                                   
|Total Assets                                                                       
|                                                                                   
|LIABILITIES AND SHAREHOLDERS EQUITY                                               
|Current Liabilities:                                                               
|Accounts payable                                                                   
|Third-party payor settlements                                                      
|Current maturities of long-term debt                                               
|Accrued expenses                                                                   
|Net current liabilities of discontinued operations                                 
|                                                                                   
|Total Current Liabilities                                                          
|Long-Term Liabilities:                                                             
|Long-term debt                                                                     
|Noncurrent liability for professional liability risks                              
|Noncurrent liabilities of discontinued operations                                  
|                                                                                   
|Total Long-term Liabilities                                                        
|Shareholders Equity:                                                              
|Common shares, without par value:                                                  
|Issued and outstanding, 4,998 at September 30, 2002 and June 30, 2002              
|Additional paid-in capital                                                         
|Retained earnings                                                                  
|Accumulated other comprehensive loss                                               
|                                                                                   
|Total Shareholders Equity                                                         
|                                                                                   
|Total Liabilities and Shareholders Equity                                         
|                                                                                   
|See notes to condensed consolidated financial statements.                          

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SUNLINK
HEALTH SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED
 STATEMENTS OF EARNINGS
(in thousands, except per share amounts)
(unaudited)

|                                                               | THREE MONTHS ENDED September 30,
|-------------------------------------------------------------- | --------------------------------
|                                                               |                                 
|                                                               |                                 
|                                                               |                                 
|Net Revenues                                                   | $                               
|Operating Expenses:                                            |                                 
|Salaries, wages and benefits                                   |                                 
|Provision for bad debts                                        |                                 
|Supplies                                                       |                                 
|Purchased services                                             |                                 
|Other operating expenses                                       |                                 
|Rent and lease expense                                         |                                 
|Depreciation and amortization                                  |                                 
|Gain on sale of property and equipment                         |                                 
|                                                               |                                 
|Operating Profit                                               |                                 
|Other Income (Expense):                                        |                                 
|Interest expense                                               |                                 
|Interest income                                                |                                 
|                                                               |                                 
|Earnings (Loss) From Continuing Operations Before Income Taxes |                                 
|Income Tax Expense                                             |                                 
|                                                               |                                 
|Earnings (Loss) From Continuing Operations                     |                                 
|Discontinued Operations:                                       |                                 
|Loss from operations of Life Sciences and Engineering Segment  |                                 
|Gain on disposal of Housewares Segment                         |                                 
|                                                               |                                 
|Earnings (Loss) from Discontinued Operations                   |                                 
|                                                               |                                 
|Net Earnings (Loss)                                            | $                               
|                                                               |                                 
|Earnings (Loss) Per Share:                                     |                                 
|Continuing Operations:                                         |                                 
|Basic                                                          | $                               
|                                                               |                                 
|Diluted                                                        | $                               
|                                                               |                                 
|Net Earnings:                                                  |                                 
|Basic                                                          | $                               
|                                                               |                                 
|Diluted                                                        | $                               
|                                                               |                                 
|Weighted-Average Common Shares Outstanding:                    |                                 
|Basic                                                          |                                 
|                                                               |                                 
|Diluted                                                        |                                 
|                                                               |                                 
|See notes to condensed consolidated financial statements.      |                                 

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SUNLINK HEALTH SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(in thousands)(unaudited)



|                                                          | THREE MONTHS ENDEDSeptember 30,
|--------------------------------------------------------- | -------------------------------
|                                                          |                                
|                                                          | 2002                           
|                                                          |                                
|Net Cash Used in Operating Activities                     | $                              
|Cash Flows From Investing Activities:                     |                                
|Proceeds from sale of property and equipment              |                                
|Expenditures for property, plant and equipment            |                                
|                                                          |                                
|Net Cash Used in Investing Activities                     |                                
|Cash Flows From Financing Activities:                     |                                
|Payment of long-term debt                                 |                                
|                                                          |                                
|Net Cash Used in Financing Activities                     |                                
|Effect of Exchange Rate Changes on Cash                   |                                
|                                                          |                                
|Net Decrease in Cash and Cash Equivalents                 |                                
|Cash and Cash Equivalents at Beginning of Period          |                                
|                                                          |                                
|Cash and Cash Equivalents at End of Period                | $                              
|                                                          |                                
|Supplemental Disclosure of Cash Flow Information:         |                                
|Cash Paid For:                                            |                                
|Interest, net of amounts capitalized                      | $                              
|                                                          |                                
|Income taxes                                              | $                              
|                                                          |                                
|See notes to condensed consolidated financial statements. |                                

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SUNLINK HEALTH
 SYSTEMS, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTSTHREE
 MONTHS ENDED SEPTEMBER 30, 2002(dollars in thousands)(unaudited)

Note 1.  Basis of
 Presentation

The accompanying unaudited
 Condensed Consolidated Financial Statements as of and for the three months ended
 September 30, 2002 have been prepared in accordance with Rule 10-01 of Regulation
 S-X of the Securities and Exchange Commission and, as such, do not include all
 information required by accounting principles generally accepted in the United
 States of America. These Condensed Consolidated Financial Statements should be read
 in conjunction with the consolidated financial statements included in the SunLink
 Health Systems, Inc. (SunLink or the Company) Annual Report
 on Form 10-K for the fiscal year ended June 30, 2002, filed on September 16, 2002.
 In the opinion of management, the Condensed Consolidated Financial Statements, which
 are unaudited, include all adjustments, consisting only of normal recurring
 adjustments, necessary to present fairly the financial position and results of
 operations for the periods indicated. The results of operations for the three months
 ended September 30, 2002 are not necessarily indicative of the results that may be
 expected for the entire fiscal year or any other interim period.

Note 2.  Business
 Operations and Corporate Strategy

SunLink operates six community
 hospitals and related businesses which were acquired on February 1, 2001. In the
 fiscal year ended March 31, 2001, SunLink redirected its business strategy toward
 the operation of community hospitals in the United States and away from European
 operations. On October 5, 2001, SunLink sold all of the capital stock of what was
 then its wholly owned United Kingdom housewares subsidiary, Beldray Limited
 (Beldray), ceasing its remaining non-U.S. business operations. See Note
 4 - Discontinued Operations. In August 2001, the Company changed its
 name to SunLink Health Systems, Inc. from KRUG International Corp. and changed its
 fiscal year-end from March 31 to June 30.

Note 3.  Potential
 Acquisition with HealthMont, Inc.

On October 15, 2002, SunLink
 announced that it and a wholly owned subsidiary of SunLink had signed a definitive
 merger agreement to acquire all of the outstanding capital stock of HealthMont, Inc.
 (HealthMont), a privately held operator of community hospitals. Upon
 consummation of the transaction, SunLink is to acquire two community hospitals:
 Memorial Hospital of Adel, a 60-bed acute-care facility in Adel, Georgia, which
 includes a 95-bed nursing home, and Callaway Community Hospital, a 49-bed acute-care
 hospital in Fulton, Missouri. HealthMont currently operates another community
 hospital in San Benito, Texas, which is to be sold prior to the completion of the
 acquisition. Upon completion of the acquisition, the Company would operate eight
 community hospitals with a total of 442 beds.

Under the terms of the
 merger agreement, SunLink would issue to the shareholders of HealthMont up to
 1,155,000 common shares of SunLink in consideration for all issued and outstanding
 capital stock of HealthMont. HealthMont currently has approximately 120 shareholders
 and approximately 6,248,000 HealthMont shares are expected to be outstanding
 immediately prior to closing. Accordingly, each HealthMont shareholder is expected
 to receive one common share of SunLink for each 5.4142 HealthMont shares
 (approximately 0.1847 of a common share of SunLink for each share of HealthMont).

5



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NOTES TO CONDENSED
 CONSOLIDATED FINANCIAL STATEMENTS (continued)

In addition, SunLink would
 issue 95,000 common shares in connection with the transaction to settle certain
 contractual obligations of HealthMont to its officers and directors. SunLink would
 also become obligated to issue approximately 20,000 common shares upon exercise of
 outstanding HealthMont options, approximately 27,000 SunLink common shares upon
 exercise of outstanding HealthMont warrants and 75,000 SunLink common shares upon
 exercise of warrants to be issued by SunLink in connection with the financing of the
 transaction.

In connection with the
 transaction, SunLink also intends to assume up to a total of $9,800 in HealthMont
 senior debt and capital lease obligations, and enter into a $3,000, 3-year term loan
 intended primarily to provide additional working capital.

Based on the closing price
 of SunLinks common shares of $2.36 on October 14, 2002, plus the amount of
 senior debt and capital lease obligations to be assumed, and including estimated
 transaction costs, the price to SunLink of the transaction would have been
 approximately $15,300. SunLinks share price at the transaction closing date
 will be used to determine the actual transaction cost.

The HealthMont acquisition
 is expected to be completed in the first calendar quarter of 2003. Completion of
 the merger is subject to a number of conditions, including regulatory approvals,
 approval of the transaction by the shareholders of both SunLink and HealthMont and
 modification of the terms of HealthMonts existing senior debt or availability
 to SunLink of alternative financing.

The unaudited net revenues of
 the two HealthMont facilities to be acquired through the merger were approximately
 $28,500, as reported by HealthMont for the twelve months ended June 30, 2002.
 SunLink does not plan to add any corporate staff or to significantly increase its
 overhead as a result of the acquisition. SunLink will not acquire HealthMonts
 corporate staff and facilities in connection with the acquisition.

In connection with the
 proposed HealthMont acquisition, SunLink expects to assume approximately $9,800 of
 HealthMont senior debt, consisting of a senior credit facility of approximately
 $8,900 and capital leases, primarily for equipment, of approximately $900. Subject
 to a number of conditions, HealthMont obtained the consent of its senior lender to
 the proposed acquisition of HealthMont by SunLink and the modification of certain
 terms of HealthMonts senior debt, including the principal repayment of $600 at
 the closing of the merger and an extension of the maturity date of the remaining
 debt through August 31, 2005. Post acquisition, the remaining senior debt is
 expected to be comprised of term loans of approximately $5,000 with interest at
 prime plus 2% per annum and revolving credit loans of approximately $3,900 with
 interest at prime plus 1 1⁄2%. Upon completion of the merger, HealthMonts
 senior lender would hold warrants to purchase 27,000 shares of SunLinks common
 shares at an exercise price of $0.01 per share.

Certain HealthMont investors
 have arranged letters of credit which support up to $1,650 of HealthMonts
 revolving credit loans. Subject to completion of the acquisition, SunLink has
 agreed, in the event the letters of credit are drawn and the proceeds reduce the
 outstanding balance of the revolving credit loans, to issue to those investors
 350,000 of SunLinks common shares in full satisfaction of HealthMonts
 reimbursement obligations under the letters of credit.

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NOTES TO CONDENSED
 CONSOLIDATED FINANCIAL STATEMENTS (continued)

In connection with the
 proposed acquisition of HealthMont, SunLink intends to enter into a
$3,000, 3-year
 secured term loan with a private investment fund. The proceeds of the loan will be
 used primarily for the repayment of $600 of HealthMonts senior debt at
 closing, payment of certain transaction costs and for working capital. The loan will
 bear interest at 15% per annum and will require SunLink to pay certain fees to the
 investment fund. SunLink will also issue warrants to purchase 75,000 of its common
 shares to the investment fund at an exercise price of $0.01 per share.

Upon consummation of the
 acquisition, the board of directors of SunLink intends to elect Gene Burleson, a
 current HealthMont director, to the unexpired the term of Ronald J. Vannuki, who
 would step down from the Companys board. SunLink also has agreed to nominate
 Mr. Burleson for election by its shareholders to a two-year term on its board of
 directors at its 2003 Annual Meeting.

Note 4.  Discontinued
 Operations

Housewares Segment  SunLink
 sold its U.K. housewares subsidiary, Beldray, on October 5, 2001 for nominal
 consideration. During the three months ended September 30, 2001, a gain from
 discontinued operations of $254 related to the disposal of the housewares segment
 was reported. The gain resulted from realized currency gains on certain
 transactions and adjustments to the foreign currency translation adjustment
 component of SunLinks shareholders equity related to the housewares
 segment. During the three months ended June 30, 2001, SunLink reported a charge to
 discontinued operations relating to Beldray of $3,989. The charge was composed of
 losses from operations of $2,433 (including an asset impairment provision of $2,088
 to reduce the carrying value of Beldrays net assets to net realizable value of
 $0) and a loss on disposal of Beldray of $1,556, including $687 for operating losses
 through the disposal date. Revenues of Beldray were $6,098 for the three months
 ended September 30, 2001.

Noncurrent liabilities of
 discontinued operations at September 30, 2002 include $1,061 relating to the
 housewares segment which represents a reserve for a portion of a guarantee by a U.K.
 subsidiary of SunLink with respect to Beldrays obligations under a lease
 covering a portion of Beldrays manufacturing location. A currently inactive
 U.K. subsidiary of SunLink has an option to repurchase the capital stock of Beldray
 for nominal consideration if any U.K. subsidiary of SunLink is called upon to
 perform under the lease guarantee, or under certain other conditions.

Industrial Segment  In
 fiscal 1989, SunLink discontinued the operations of its industrial segment and
 subsequently disposed of substantially all related net assets. However, obligations
 may remain relating to product liability claims for products sold prior to the
 disposal. Noncurrent liabilities of discontinued operations at September 30, 2002
 and June 30, 2002 of $589 and $637, respectively, relate to the industrial segment.

Over the past thirteen years
 SunLink has discontinued operations carried on by its former industrial, U.K.
 leisure marine, life sciences and engineering, and U.K. child safety segments, as
 well as the U.K. housewares segment. Reserves for losses relating to discontinued
 operations of these segments represent SunLinks best estimate of the possible
 liability for property, product liability, and other claims for which it may incur
 liability. These estimates are based on SunLinks judgments using currently
 available information as well as, in certain instances, consultation with its
 insurance carriers and legal counsel. SunLink historically has purchased insurance
 policies to reduce certain of its product liability exposure and may continue to

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NOTES TO CONDENSED
 CONSOLIDATED FINANCIAL STATEMENTS (continued)

purchase such insurance
 if available at commercially reasonable rates. While SunLink has based its
 estimates on its evaluation of available information it is not possible to predict
 with certainty the ultimate outcome of many contingencies relating to discontinued
 operations. SunLink intends to adjust its estimates of the reserves as additional
 information is developed and evaluated. However, management believes that the final
 resolution of these contingencies will not have a material adverse impact on the
 financial position, cash flows, or results of operations of SunLink.

Note 5.  Recent
 Accounting Pronouncements

In August 2001, the
 FASB issued SFAS No. 144, Impairment or Disposal of Long-Lived Assets. The
 provisions of this statement provide a single accounting model for the impairment or
 disposal of long-lived assets. As required by SFAS No. 144, SunLink adopted this
 new accounting standard on July 1, 2002. During the quarter ended September 30,
 2002, there was no impact of adopting SFAS No. 144 reflected in the Companys
 financial statements, however SunLink continues to review the impact of the standard
 on its long-lived assets, in particular the current facility for Mountainside
 Medical Center in Jasper, Georgia where a replacement hospital is currently being
 constructed.

In June 2002, the FASB
 issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
 Activities. SFAS No. 146 requires the recording of costs associated with exit or
 disposal activities at their fair values when a liability has been incurred. Under
 previous guidance, certain exit costs were accrued upon managements commitment
 to an exit plan, which is generally before an actual liability has been incurred.
 SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated
 after December 31, 2002.

Note 6.  Long-Term
 Debt



|                                                                                    |  | September 30, |   | June 30,
|----------------------------------------------------------------------------------- |  | ------------- | - | --------
|                                                                                    |  | 2002          |   | 2002    
|                                                                                    |  |               |   |         
|Senior subordinated note, net
 of unamortized discount of $2,155 and $2,278         |  |               | $ | 17,382  
|Senior subordinated zero coupon
 note, net of unamortized discount of $290 and $339 |  |               |   | 1,710   
|Term loan                                                                           |  |               |   | 5,358   
|Other                                                                               |  |               |   | 117     
|                                                                                    |  |               |   |         
|                                                                                    |  |               |   | 24,567  
|Less current maturities                                                             |  |               |   | (963    
|                                                                                    |  |               |   |         
|                                                                                    |  |               | $ | 23,604  
|                                                                                    |  |               |   |         

In connection with
 the acquisition of SunLinks six existing hospitals, SunLink Healthcare Corp.
 (SHC), a wholly owned subsidiary of the Company, issued an 8.5% senior
 subordinated note in the face amount of $17,000 and a senior subordinated zero
 coupon note in the face amount of $2,000, both to the seller. The senior
 subordinated note is due on January 31, 2006 with interest payable semiannually
 either in cash or additional promissory notes through February 1, 2003 and in cash
 thereafter. Additional promissory notes of $1,999 for interest from February 1, 2001
 through May 31, 2002 have been issued and the accrued interest payable at September
 30, 2002 of $538 is included in the senior subordinated note. The stated interest
 rate of 8.5% on the senior subordinated note was considered a below-market interest
 rate at the date of issuance, therefore,

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NOTES TO CONDENSED
 CONSOLIDATED FINANCIAL STATEMENTS (continued)

the note was discounted
 to estimated market value at an effective interest rate of 12.3%. The original
 discount recorded on the senior subordinated note was $2,809.

The purchase agreement
 for the six hospitals includes a provision for a potential adjustment to
 the senior subordinated note to the extent working capital at the purchase date is
 determined to be greater or less than an agreed-upon amount. SunLink has proposed a
 working capital adjustment which would reduce the balloon note by $1,000. The seller
 has not agreed to the adjustment and SunLink and the seller currently are seeking to
 conclude the working capital adjustment under the dispute resolution provisions of
 the purchase agreement. No adjustment for any working capital settlement has been
 made to the balloon note at September 30, 2002.

The senior subordinated zero
 coupon note is due January 31, 2004. The interest rate on the senior subordinated
 zero coupon note was considered less than the market rate at the date of issuance,
 therefore, the note was discounted to an estimated market interest rate of 11.3%.
 The original issue discount on the senior subordinated zero coupon note was $594.

The discounts on the
 long-term debt were determined by SunLink in consultation with its financial
 advisor based on high-yield debt instruments of similar health care providers and
 are being amortized over the term of the related debt instrument using the effective
 interest method. For the three months ended September 30, 2002 and 2001, SunLink
 recognized amortization expense on the discounts of $172 and $126, respectively.

The loan agreement pursuant
 to which the senior subordinated note and the senior subordinated zero coupon note
 were issued requires that SHC grant to the lender a security interest in and
 mortgage on collateral consisting of SHC and its subsidiaries real and
 personal property, unless SHC has outstanding senior indebtedness that meets certain
 conditions. The senior subordinated note and the senior subordinated zero coupon
 note presently are not collateralized. Each of the individual hospital subsidiaries
 of SHC is a guarantor of these notes. Further, these notes are subordinate in
 payment and collateral to all defined senior indebtedness of SHC which in the
 aggregate does not exceed $15,000, other than debt incurred in connection with
 certain future acquisitions.

On January 4, 2002, SunLink
 entered into a $14,000 credit facility comprised of a 36-month secured revolving
 line of credit for up to $8,000 with interest at prime plus 1.25% and a $6,000
 secured term loan repayable over 66 months at an interest rate of 9.78%. The
 availability of borrowings under the revolving credit facility is based upon, among
 other things, a borrowing base keyed to the level of SHC receivables which, based
 upon the Companys estimates, provides borrowing capacities of approximately
 $8,000 at September 30, 2002. The revolving credit facility is secured by the
 patient accounts receivable of SHC. No amount was outstanding on the revolving
 credit facility at September 30, 2002. The net proceeds from the term loan of $5,800
 are being used for working capital and to fund a portion of SunLinks hospital
 capital projects which include a new replacement hospital in Jasper, Georgia, and a
 new emergency room at its hospital in Ellijay, Georgia. The term loan is secured by
 liens on the real and personal property, except for patient accounts receivables, as
 well as the capital stock owned by SHC and its subsidiaries. Also, each of the
 hospital subsidiaries is a guarantor of the loan.

On September 30, 2002, SunLink
 entered into a $6,000 secured bank financing facility in connection with its
 Mountainside Medical Center replacement hospital currently under construction in
 Jasper, Georgia. The replacement hospital is scheduled to open in May 2003. This
 financing facility includes a construction loan of up to $6,000 with interest at
 prime plus 1% per annum. SunLink has funded the construction costs from the term
 loan and internal funds.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS (continued)SunLink expects to fund additional
 construction costs from availability under its
 revolving credit agreement and expects funding under the construction loan to commence
 during its third fiscal quarter ending March 31, 2003.The financing facility
 also includes a 20-year mortgage loan with interest at prime plus
 1% per annum or, at SunLinks option, interest at the 5-year U.S. Treasury Constant
 Maturity Yield plus 3 1⁄2%. The mortgage loan interest rate is adjustable every 5 years.
 The construction loan may be converted to a 20-year mortgage loan three months after
 completion of construction, subject to certain conditions. The financing facility
 requires SunLink to comply with certain conditions and covenants including hospital
 financial and operational covenants, information requirements and limitations on secured
 debt by the hospital subsidiary.

Note 7.  Comprehensive Earnings (Loss)

Comprehensive earnings (loss) for
 SunLink includes foreign currency translation and minimum pension liability adjustments.
 Total comprehensive earnings (loss) for the following periods was as follows:



|                                         | Three Months Ended
|---------------------------------------- | ------------------
|                                         |                   
|                                         | September 30, 2002
|                                         |                   
|                                         |                   
|Net earnings (loss):                     | $                 
|Other comprehensive income net of tax:   |                   
|Change in equity due to:                 |                   
|Foreign currency Translation adjustments |                   
|                                         |                   
|Comprehensive earnings (loss)            | $                 
|                                         |                   

Note 8.  Contingencies

As discussed in Note 4  Discontinued
 Operations, a U.K. subsidiary of SunLink remains contingently liable as guarantor
 of Beldrays obligations under a lease covering a portion of Beldrays
 manufacturing location.

Reserves relating to discontinued operations
 represent managements best estimates of possible liability for the contingent
 liabilities of discontinued operations. While SunLink has based its estimates on
 its evaluation of available information, it is not possible to predict with certainty
 the ultimate outcome of many contingencies relating to discontinued operations.
 SunLink intends to adjust its estimates of the reserves as additional information
 is developed and evaluated. However, management believes that the final resolution
 of these contingencies will not have a material adverse impact on the financial
 position, cash flows, or results of operations of SunLink.

As of September 30, 2002, SunLink had future
 commitments for capital expenditures relating to the new Jasper, Georgia hospital
 of approximately $10,300 and for the new emergency room at the North Georgia Medical
 Center in Ellijay, Georgia, of approximately $1,400. Subject to internal approval
 of specific capital items and the availability of funds, SunLink expects to spend
 approximately $1,750 in additional capital expenditures during the remaining nine
 months of the fiscal year ended June 30, 2003, primarily for new and replacement
 equipment.

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##### Table of Contents



NOTES TO CONDENSED CONSOLIDATED FINANCIAL
 STATEMENTS (continued)

SunLink is a party to claims and litigation
 incidental to its business, as to which it is not currently possible to determine
 the ultimate liability, if any. Based on an evaluation of information currently
 available and consultation with legal counsel, management believes that resolution
 of such claims and litigation is not likely to have a material effect on the financial
 position, cash flows, or results of operations of SunLink.

11



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ITEM 2. MANAGEMENTS
 DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS(dollars in thousands,
 except per share and admissions data)

Recent Developments

On October
 15, 2002, SunLink announced that it and a wholly owned subsidiary of SunLink signed
 a definitive merger agreement to acquire all of the outstanding shares of HealthMont,
 Inc. (HealthMont), a privately held operator of community hospitals.
 Upon consummation of the transaction, SunLink would acquire two community hospitals:
 Memorial Hospital of Adel, a 60-bed acute-care facility in Adel, Georgia, which
 includes a 95-bed nursing home, and Callaway Community Hospital, a 49-bed acute-care
 hospital in Fulton, Missouri. HealthMont currently operates another community hospital
 in San Benito, Texas, which is to be sold prior to the acquisition. Upon completion
 of the acquisition, SunLink would operate eight community hospitals with a total
 of 442 beds.

Based on the
 closing price of SunLinks common shares of $2.36 on October 14, 2002, plus
 the amount of senior debt and capital lease obligations to be assumed and including
 estimated transaction costs, the price of the transaction would be approximately
 $15,300. SunLinks share price at the transaction closing date will be used
 to determine the actual transaction cost.

Under the
 terms of the merger agreement, we are to issue to the shareholders of HealthMont
 up to 1,155,000 of SunLink common shares in consideration for all issued and outstanding
 stock of HealthMont. HealthMont currently has approximately 120 shareholders and
 expects to have approximately 6,248,000 shares outstanding immediately prior to
 closing. Accordingly, each HealthMont shareholder is expected to receive one SunLink
 common share for each 5.4142 HealthMont shares (approximately 0.1847 of a SunLink
 common share for each share of HealthMont).

SunLink is
 to issue 95,000 additional SunLink common shares in connection with the transaction
 to settle certain contractual obligations of HealthMont to its officers and directors.
 We will also reserve for issuance approximately 20,000 common shares in connection
 with certain outstanding HealthMont options, approximately 27,000 common shares
 to be issued upon exercise of outstanding HealthMont warrants and 75,000 common
 shares to be issued upon exercise of warrants which we will issue in connection
 with the financing of the transaction.

In connection
 with the transaction, we will also assume up to $9,800 in HealthMont senior debt
 and capital lease obligations, and enter into a $3,000, 3-year term loan intended
 primarily to provide additional working capital.

The acquisition
 of HealthMont is expected to close in the first calendar quarter of 2003. Completion
 of the merger is subject to a number of conditions, including regulatory approvals,
 approval of the transaction by shareholders of both SunLink and HealthMont and modification
 of the terms of HealthMonts existing senior debt or the availability to SunLink
 of alternative financing.

The unaudited
 net revenues of the two HealthMont facilities to be acquired through the merger
 were approximately $28,500, as reported by HealthMont for the twelve months ended
 June 30, 2002. HealthMont reported unaudited EBITDA (earnings before interest,
 taxes, depreciation and amortization) of approximately $3,000 for the twelve months
 ended June 30, 2002 for the two facilities to be acquired. HealthMonts corporate
 staff and facilities will not be acquired in connection with the acquisition and
 we do not plan to add any corporate staff or to significantly increase our overhead
 as a result of our proposed acquisition of HealthMont.

12



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##### Table of Contents



Financial Summary





|                                                               | THREE MONTHS ENDED September 30,
|-------------------------------------------------------------- | --------------------------------
|                                                               |                                 
|                                                               | 2002                            
|                                                               |                                 
|NET REVENUES:                                                  |                                 
|Community hospital segment                                     | $                               
|                                                               |                                 
|EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES:       |                                 
|Community hospital segment                                     | $                               
|Corporate expenses                                             |                                 
|                                                               |                                 
|                                                               |                                 
|Interest expense                                               |                                 
|Interest income                                                |                                 
|                                                               |                                 
|Earnings (Loss) from Continuing Operations Before Income Taxes | $                               
|                                                               |                                 
|Equivalent Admissions                                          |                                 
|                                                               |                                 
|Revenue per Equivalent Admissions                              | $                               
|                                                               |                                 

Results of Operations

All
of our net revenues relate to our U.S. community hospital segment which was acquired
 February 1, 2001. The operations of our former U.K. housewares business segment,
 which was disposed of on October 5, 2001, are reported in discontinued operations
 for the three months ended September 30, 2001.

Our U.S. community
 hospital segment reported aggregate net revenues of $23,801, a total of 4,662 equivalent
 admissions and revenues per equivalent admission of $5,105 for the quarter ended
 September 30, 2002 compared to net revenues of $21,549, a total of 4,067 equivalent
 admissions and revenues per equivalent admission of $5,299 for the three months
 ended September 30, 2001. The 10.4% increase in net revenues in the current year
 was due to the 14.6% increase in equivalent admissions. Total surgeries increased
 9.7% in the current year. We added 13 net new doctors during the year ended June
 30, 2002 and six net new doctors during the three months ended September 30, 2002.
 We also have expended approximately $4,300 for capital expenditures to upgrade services
 and facilities since the acquisition on February 1, 2001. We believe the upgraded
 services and facilities and the new doctors contributed to the 10.4% increase in
 net revenues for the quarter ended September 30, 2002 compared to the same period
 last year. We continue to seek increased equivalent admissions by attracting additional
 physicians to our hospitals, further upgrading the services offered by the hospitals
 and improving the hospitals physical facilities. The source of the increase
 in the current years net revenues was primarily Medicare and Medicaid payors
 while net revenues from commercial and private payors were relatively unchanged.
 Net outpatient service revenues for the quarter ended September 30, 2002 were $12,001
 or 50.4% of total net revenues, an increase of 12.4% from the quarter ended September
 30, 2001 which included net outpatient service revenues of $10,673 or 49.5% of total
 net revenues.

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The following
 table sets forth the percentage
 of net patient revenues from various payors in the Companys hospitals for
 the periods indicated:



|                    | Three months Ended September 30,
|------------------- | --------------------------------
|                    |                                 
|                    | 2002                            
|                    |                                 
|Source              |                                 
|Medicare            | 48.4                            
|Medicaid            | 14.0                            
|Self pay            | 7.9                             
|Private and
 others | 29.7                            
|                    |                                 
|                    | 100.0                           
|                    |                                 



Operating
 expenses, including depreciation, were $22,526 and $21,465 for the quarters ended
 September 30, 2002 and 2001, respectively.



|                             | Operating Expenses as % of Net RevenuesThree Months Ended September 30,
|---------------------------- | -----------------------------------------------------------------------
|                             |                                                                        
|                             | 2002                                                                   
|                             |                                                                        
|Salaries, wages and benefits | 45.7                                                                   
|Provision for bad debts      | 11.7                                                                   
|Supplies                     | 11.4                                                                   
|Purchased services           | 8.0                                                                    
|Other operating expenses     | 14.0                                                                   
|Rent and lease expense       | 2.3                                                                    

Most operating
 expense categories decreased as a percentage of net revenues in the current year
 due to the increased net revenues and efforts to control costs in the hospitals.
 Salaries, wages and benefits expense decreased as a percentage of net revenues
 for the current quarter due to cost control initiatives undertaken in each facility
 to reduce labor costs. The provision for bad debts was 11.7% of net revenues in
 the quarter, a decrease of 1.4% of net revenues from the prior year due to improved
 collections and increased Medicare and Medicaid net revenues as a percentage of
 total net revenues. Improved collections were facilitated by the hospitals implementing
 additional business office systems and procedures designed to minimize bad debts.
 Supplies expense increased slightly as a percentage of net revenues in the current
 year due to the 9.7% increase in total surgeries. The increase in other operating
 expenses as a percent of net revenue in the current year reflects increased physician
 guarantee expense in the current year resulting from the 19 net new physicians
 recruited during the last 15 months and increased insurance expense.

Interest expense
 was $749 and $709 for the three months ended September 30, 2002 and 2001, respectively.
 This increase in the current year was due to our increased debt level resulting
 from the term loan closed on January 4, 2002 and the increasing principal balance
 of the senior subordinated debt due to the interest paid in kind. Cash interest
 paid during the three months ended September 30, 2002 was $138, including $87 of
 interest capitalized in property, plant and equipment.

We recorded
 income tax expense of $92, $50 federal and $42 for state, for the three months ended
 September 30, 2002. We had a U.S. net operating loss carryforward of approximately
 $6,300 at September 30, 2002. Use of this net operating loss carryforward is subject
 to the limitations of the provisions of Internal Revenue Service Code Section 382.
 As a

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##### Table of Contents



result, not all of the net operating loss
 carryforward is useable to offset federal taxable income in the current year and
 federal income tax expense results. We have provided a valuation allowance for the
 entire amount of our deferred tax assets (the majority of which is the U.S. net
 operating loss carryforward) as it is our assessment based upon the criteria identified
 in SFAS No. 109 that it is currently more likely than not that none of the deferred
 tax asset will be realized through future taxable earnings or implementation of
 tax planning strategies. We recorded no income tax expense in the three months ended
 September 30, 2001 due to the loss before tax for such prior period.



Our earnings
 from continuing operations were $450 ($0.08 per share fully diluted) in the quarter
 ended September 30, 2002 compared to a loss from continuing operations of $592 ($0.12
 per fully diluted share) in the comparable quarter last year. Our operating profit
 of $1,275 for the three months ended September 30, 2002 resulted from operating
 profit of $1,673 achieved by the community hospital segment offset by corporate
 expenses of $398. The prior year operating profit of $103 resulted from operating
 profit of $598 achieved by our community hospital segment offset by corporate expenses
 of $495. The increased operating profit of our community hospital segment in the
 current year resulted from the increased net revenues.


Liquidity and Capital Resources



We used $1,685
 of cash from operating activities during the three months ended September 30, 2002
 compared to $449 used during the comparable period last year. The cash used in the
 current year resulted primarily from our use of cash for working capital of $3,123
 and interest paid of $51 offset by cash generated from net income of $435, and the
 noncash deprecation expense of $356 and non-cash interest expense of $698. Receivables
 of our community hospital segment increased $1,218 due to the increased net revenues
 and accounts payable and accrued expenses decreased $783, primarily from the payment
 of construction costs recorded in accounts payable at the beginning of the year
 and payment of accrued expenses.




We expended
 $3,081 for capital improvements at our hospitals during the three months ended September
 30, 2002. In addition to routine capital expenditures of $550 during the three
 months, primarily for new and replacement equipment, we expended $2,183 for costs
 related to the replacement hospital in Jasper, Georgia and $348 for costs related
 to a new emergency room at North Georgia Medical Center in Ellijay, Georgia. We
 believe an attractive physical facility assists in recruiting quality staff and
 physicians, as well as attracting patients. Subject to availability of financing,
 we expect to expend approximately $13,500 for capital expenditures during the remaining
 nine months of the fiscal year ended June 30, 2003, approximately $10,300 of which
 will be used for the replacement hospital in Jasper, Georgia and approximately $1,400
 will be used for the new emergency in Ellijay, Georgia. The total estimated cost
 of the new Jasper hospital is approximately $15,800 of which approximately $5,500
 has been expended as of September 30, 2002. Our capital expenditures are contemplated
 to be funded by a new $6,000 construction facility, the $8,000 revolving line of
 credit and cash generated from operations of the community hospital segment.




Our primary
 sources of liquidity are funds from operations and borrowing under our existing
 credit facilities. Our credit facilities include an $8,000 secured revolving line
 of credit which matures December 31, 2004 and a $6,000 secured bank financing facility
 for the construction of the Jasper replacement hospital The net proceeds from the
 term loan in the amount of $5,800 have been used for working capital and to fund
 a portion of the hospital capital projects which include a replacement hospital
 in Jasper, Georgia, and a new emergency room at the Companys hospital in Ellijay,
 Georgia. At September 30, 2002, the term loan balance was $5,358.


15



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##### Table of Contents





The availability
 of borrowing under the revolving line of credit is based upon, among other things,
 a borrowing base keyed to the level of the hospitals receivables. Based upon
 SunLinks estimates, the secured revolving line of credit provides borrowing
 capacity of approximately $8,000 at September 30, 2002. If the amount or
 quality of receivables is lower than expected, our borrowing capacity under the
 secured revolving line of credit will also be lower. If SunLink experiences a material
 adverse change in its businesses, assets, financial condition, management, or operations,
 or the value of the collateral securing the credit facility, we may be unable to
 draw on the revolving line of credit.




On September
 30, 2002, we closed a $6,000 secured bank financing facility in connection with
 the construction of our Mountainside Medical Center replacement hospital currently
 under construction in Jasper, Georgia. The replacement hospital is scheduled to
 open in May 2003. This financing facility includes a construction loan of up to
 $6,000 with interest at prime plus 1% per annum. We expect funding under the construction
 loan to commence during the quarter ending March 31, 2003. We have funded construction
 costs to date from the term loan and internal funds and we expect to fund additional
 construction costs from availability under our revolving credit facility and the
 construction loan.




The secured
 bank financing facility also includes a 20-year mortgage loan with interest at prime
 plus 1% per annum or, at our option, interest at the 5-year U.S. Treasury Constant
 Maturity Yield plus 3 1⁄2%. The mortgage loan interest rate is adjustable every
 5 years. The construction loan may be converted to the 20-year mortgage loan three
 months after completion of construction, subject to certain conditions.




The secured
 bank financing facility requires us to comply with certain conditions and covenants
 including hospital financial and operational covenants, information requirements
 and limitations on secured debt by our hospital subsidiary which owns and operates
 the Jasper, Georgia hospital.




The debt
 capacity of the our subsidiary, SunLink Healthcare Corp. (SHC), which holds the
 stock of our existing six-hospital subsidiaries, is limited and is subject to certain
 leverage tests by its loan agreements. Under the most limiting of such tests, SHC
 would, at September 30, 2002, have been able to incur up to approximately $9,600
 of additional indebtedness. This does not include any amount relating to the HealthMont
 acquisition which is not currently expected to involve SHC.




Contractual
 obligations related to long-term debt, noncancellable operating leases and physician
 guarantees at September 30, 2002 were as follows:


Contractual Obligations



|Payments           |  | Long-Term |        | Operating |  | Physician 
|------------------ |  | --------- | ------ | --------- |  | ----------
|due in:            |  | Debt      |        | Leases    |  | Guarantees
|                   |  |           |        |           |  |           
|1 year             |  | $         | 963    |           |  | $         
|2 years            |  |           | 2,768  |           |  |           
|3 years            |  |           | 1,153  |           |  |           
|4 years            |  |           | 18,648 |           |  |           
|5 years            |  |           | 1,035  |           |  |           
|More than
 5 years |  |           |       |           |  |           
|                   |  |           |        |           |  |           
|                   |  | $         | 24,567 |           |  | $         
|                   |  |           |        |           |  |           

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##### Table of Contents





At September
 30, 2002, we had outstanding long-term debt of $24,567, of which $19,092 was incurred
 in connection with our purchase on February 1, 2001 of our six existing community
 hospitals and related businesses, $5,358 was outstanding from the term loan and
 $117 related to capital leases. Our U.S. debt includes a seller financed balloon
 note of $17,382 and a seller financed zero coupon note of $1,710. The balloon note,
 due January 31, 2006, has a face amount of $17,000 and a stated interest rate of
 8.5% which, because it was considered a below market interest rate at the date of
 issuance, has been discounted for financial reporting purposes to a market interest
 rate of 12.3%. The balloon note has a payment-in-kind (PIK) feature for interest
 accrued through January 31, 2003. Interest due and payable through that date may
 be paid in additional balloon notes due in 2006 and we presently intend to issue
 PIK notes for interest due through January 31, 2003. Additional promissory notes
 have been issued for interest payable from February 1, 2001 to May 31, 2002 totaling
 $1,999 and the interest accrued through September 30, 2002 of $538 has been included
 in the principal amount of the balloon note at September 30, 2002.




The purchase
 agreement for the six hospitals provides for an adjustment to the balloon note to
 the extent working capital at the purchase date was greater or less than an agreed
 upon amount. We have submitted to the seller a proposed working capital adjustment
 which would reduce the balloon note by $1,000. The seller has not agreed to the
 adjustment and the Company and seller currently are seeking to conclude the working
 capital settlement under the dispute resolution provisions of the purchase agreement.
 No adjustment for any working capital settlement has been made to the balloon note
 at September 30, 2002.




The zero coupon
 note is due January 31, 2004, has a face amount of $2,000, and has been discounted
 to a market interest rate of 11.3%. The principal amount of the zero coupon note
 is subject to reduction for certain indemnified items pursuant to the purchase agreement.




Our contingent
 obligations, other than with respect to our existing operations, include potential
 product liability claims for products manufactured and sold before the disposal
 of our discontinued industrial segment in fiscal 1989, and for guarantees of certain
 obligations of former non-U.S. subsidiaries. We have provided an accrual at September
 30, 2002 related to a portion of the guarantee by one of our U.K. subsidiaries
 of a lease covering a portion of a manufacturing facility utilized by our former
 U.K. housewares operations. We are currently in the process of liquidating two dormant
 subsidiaries in Germany and France. Based upon our best estimates of potential
 liabilities, no material amounts are reserved for any contingencies related to
 these liquidations.




We believe
 we have adequate financing and liquidity to support our current level of operations
 through the end of the next fiscal year. As noted above, our current sources of
 liquidity are our $8,000 revolving credit facility, our $6,000 secured financing
 facility related to the hospital being constructed in Jasper, Georgia and cash generated
 from our community hospital operations. The availability under the revolving credit
 facility is based upon the levels of our receivables. The current availability
 of approximately $8,000 could be adversely affected by, among other things, decreases
 in receivables due to lower demand for our services by patients, change in patient
 mix and changes in terms and levels of government and private reimbursement for
 services. Cash generated from operations could be adversely affected by, among other
 things, lower patient demand for our services, higher operating costs (including,
 but not limited to, salaries, wages and benefits, provisions for bad debts, general
 liability and other insurance costs, cost of pharmaceutical drugs and other operating
 expenses), or by changes in terms and levels of government and private reimbursement
 for services and the regulatory environment of the community hospital segment.


17



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##### Table of Contents



Impact
 of Potential Acquisition of HealthMont on Liquidity and Capital Resources



In connection
 with the proposed acquisition of HealthMont, we expect to assume approximately $9,800
 in HealthMont senior debt consisting of a senior credit facility of approximately
 $8,900 and capital leases, primarily for equipment, of approximately $900. Subject
 to a number of conditions, HealthMont has obtained the consent of its senior lender
 to our proposed acquisition of HealthMont and the modification of certain terms
 of HealthMonts senior credit facility, which include a principal repayment
 of $600 at the closing of the merger and an extension of the maturity date of the
 remaining debt through August 31, 2005. Post acquisition, the remaining senior credit
 facility is expected to be comprised of term loans of approximately $5,000 with
 interest at prime plus 2% per annum and revolving credit loans of approximately
 $3,900 with interest at prime plus 1 1⁄2%.




Certain
 HealthMont investors have arranged letters of credit which support up to $1,650 of HealthMonts
 revolving credit loans. We have agreed that if the acquisition is completed
 and, in the event the letters of credit are drawn and the proceeds reduce the outstanding
 balance of the revolving credit loans, to issue to these investors 350,000 of the
 SunLink common shares in full satisfaction of HealthMonts reimbursement obligations
 under the letters of credit.




In connection
 with the proposed acquisition of HealthMont, we will enter into a
$3,000, 3-year,
 secured term loan with a private investment fund. The proceeds of such loan will
 be used primarily for working capital, including to repay $600 of HealthMonts
 senior debt at closing and to pay certain transaction costs. The loan will bear
 interest at 15% per annum and requires SunLink to pay certain fees and issue warrants
 to the lender to purchase 75,000 of SunLinks common shares at $0.01 per share.


Certain Cautionary Statements



In addition
 to historical information, Items 1 and 2 of this report contain certain forward-looking
 statements within the meaning of the safe harbor for forward-looking statements
 contained in the Private Securities Litigation Reform Act of 1995. Forward-looking
 statements include all statements that do not relate solely to historical or current
 facts, and can be identified by the use of words such as may, believe,
 will, expect, project, estimate,
 anticipate, plan, or continue. These forward-looking
 statements are based on the current plans and expectations of the Company and are
 subject to a number of risks, uncertainties and other factors which could significantly
 affect current plans and expectations and the future financial condition and results
 of the Company. These factors, which could cause actual results , performance and
 achievements to differ materially from those anticipated, include, but are not limited
 to:


General Business Conditions



|- | general economic
 and business conditions in the U.S. both nationwide and in the states in which we
 operate hospital facilities;                                                 
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|- | the competitive
 nature of the U.S. community hospital business;                                                                                                                  
| 
|- | demographic
 changes in areas where we operate hospital facilities;                                                                                                               
| 
|- | the availability
 of cash to fund working capital, renovations and capital improvements at existing
 hospital facilities and for acquisitions and replacement hospital facilities;
| 
|- | changes in
 accounting principles generally accepted in the U.S.; and,                                                                                                            
| 
|- | fluctuations
 in the market value of equity securities including SunLink common shares;                                                                                           

18



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##### Table of Contents



Operational Factors



|- | the availability
 of, and our ability to attract and retain, sufficient qualified staff physicians,
 management and staff personnel for our hospital operations;     
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|- | timeliness
 of reimbursement payments received under government programs;                                                                                            
| 
|- | restrictions
 imposed by debt agreements;                                                                                                                            
| 
|- | the cost and
 availability of insurance coverage including professional liability (e.g., medical
 malpractice) and general liability insurance;                      
| 
|- | the efforts
 of insurers, healthcare providers, and others to contain healthcare costs;                                                                              
| 
|- | the impact
 on hospital services of the treatment of patients in lower acuity healthcare settings,
 whether with drug therapy or via alternative healthcare services;
| 
|- | changes in
 medical and other technology; and,                                                                                                                       
| 
|- | increases
 in prices of materials and services utilized in our hospital operations;                                                                                  

Liabilities, Claims and Obligations



|- | claims under
 leases, guarantees, and other obligations relating to discontinued operations, acquired
 subsidiaries and former subsidiaries;
|- | --------------------------------------------------------------------------------------------------------------------------------------------
| 
|- | potential
 adverse impact of known and unknown government investigations;                                                                   
| 
|- | claims for
 product and environmental liabilities from continuing and discontinued operations;
 and,                                        
| 
|- | professional,
 general, and other claims which may be asserted against us;                                                                  

Regulation and Governmental Activity



|- | existing and
 proposed governmental budgetary constraints:                                                                                                                                                                                          
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 
|- | the regulatory
 environment for our businesses, including state Certificate of Need laws and regulations,
 rules and judicial cases relating thereto;                                                                                               
| 
|- | possible changes
 in the levels and terms of government (including Medicare, Medicaid and other programs)
 and private reimbursement for the Companys healthcare services including the
 payment arrangements and terms of managed care agreements;
| 
|- | changes in
 or failure to comply with Federal, state or local laws and regulations affecting
 the healthcare industry; and,                                                                                                                         
| 
|- | the possible
 enactment of Federal healthcare reform laws or reform laws in states where we operate
 hospital facilities (including Medicaid waivers and other reforms);                                                                            

Acquisition Related Matters



|- | our ability
 to integrate acquired hospitals and implement our business strategy; and,
|- | --------------------------------------------------------------------------------------
| 
|- | competition
 in the market for acquisition of hospitals and healthcare facilities.    



Except as
 required by law, we undertake no obligation to publicly update these forward-looking
 statements, whether as a result of new information, future events or otherwise.
 The foregoing are significant factors we think could cause our actual results to
 differ materially from expected results. However, there could be other additional
 factors besides those listed herein that also could affect SunLink in an adverse
 manner.


Critical Accounting Policies and Estimates



The unaudited
 Condensed Consolidated Financial Statements herein have been prepared in accordance
 with Rule 10-01 of Regulation S-X of the SEC, and as such, do not include all information
 required by accounting principles generally accepted in the United States


19



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##### Table of Contents



of America. These Condensed
 Consolidated Financial Statements should be read in conjunction
 with the consolidated financial statements included in the Companys Annual
 Report on Form 10-K for the fiscal year ended June 30, 2002, filed with the SEC
 on September 16, 2002. In the opinion of management, the Condensed Consolidated
 Financial Statements as of and for the three months ended September 30, 2002, which
 are unaudited, include all adjustments, consisting only of normal recurring adjustments,
 necessary to present fairly the financial position and results of operations for
 the periods indicated. The preparation of these financial statements requires management
 to make estimates and assumptions that affect the reported amounts of assets and
 liabilities and disclosure of contingent assets and liabilities at the date of the
 financial statements and the reported amounts of revenues and expenses during the
 reporting period. Actual results may differ from these estimates under different
 assumptions or conditions.



In January
 2002, the SEC issued disclosure guidance for critical accounting policies.
 The SEC defines critical accounting policies as those that require
 application of managements most difficult, subjective or complex judgments,
 often as a result of the need to make estimates about the effect of matters that
 are inherently uncertain and may change in subsequent periods.




The following
 is not intended to be a comprehensive list of all of our accounting policies. In
 many cases, the accounting treatment of a particular transaction is specifically
 dictated by accounting principles generally accepted in the United States of America,
 with no need for managements judgment in their application. There are also
 areas in which managements judgment in selecting an available alternative
 would not produce a materially different result.




We have
 identified the following as accounting policies critical to us:




Management
 Estimates  The preparation of financial statements in conformity with accounting
 principles generally accepted in the United States of America requires management
 to make estimates and assumptions that affect the reported amounts of assets and
 liabilities and disclosures of contingent assets and liabilities at the date of
 the financial statements and the reported amounts of revenues and expenses during
 the reporting period. Some of the more significant estimates made by management
 involve reserves for adjustments to net patient service revenues, evaluation of
 the recoverability of assets, including accounts receivable, and the assessment
 of litigation and contingencies, including income taxes and related tax asset valuation
 allowances, all as discussed in more detail in the remainder of this subsection.




Net Patient
 Service Revenues  Like all operators of community hospitals, we have agreements
 with third-party payors that provide for payments at amounts different from established
 charges. Payment arrangements vary and include prospectively determined rates per
 discharge, reimbursed costs, discounted charges and per diem payments. Our patient
 service revenues are reported as services are rendered at the estimated net realizable
 amounts from patients, third-party payors, and others. Estimated reductions in revenues
 to reflect agreements with third-party payors and estimated retroactive adjustments
 under such reimbursement agreements are accrued during the period the related services
 are rendered and are adjusted in future periods as interim and final settlements
 are determined. Significant changes in reimbursement levels for services under
 government and private programs could significantly impact the estimates used to
 accrue such revenue deductions.




Allowance
 for Doubtful Accounts  Accounts receivable are reduced by an allowance
 for amounts estimated to become uncollectable in the future. Substantially all
 of the Companys receivables are related to providing healthcare services to
 hospital facility patients. The Companys calculation of the allowance for
 doubtful accounts is based generally upon our historical collection experience for
 each type of payor. The allowance amount is computed by applying allowance percentages
 to amounts included in specific payor categories of patient accounts receivable.
 Significant changes in reimbursement levels for services under government


20



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##### Table of Contents



and private programs could significantly impact the
 estimates used to provide the allowance for doubtful accounts.



Risk
 Management  We are exposed to various risks of loss from medical malpractice and
 other claims and casualties; theft of, damage to, and destruction of assets; business
 interruption; errors and omissions; employee injuries and illnesses; natural disasters
 (including earthquakes); and, employee health, dental, and accident benefits. Commercial
 insurance coverage is purchased for a portion of claims arising from such matters.
 When, in our judgment, claims are sufficiently identified, we accrue a liability
 for estimated costs and losses under such claims, net of estimated insurance recoveries.




In connection
 with our acquisition of our existing six hospitals, we assumed responsibility for
 professional liability claims reported after February 1, 2001 (acquisition date),
 and the previous owner retained responsibility for all known and filed claims prior
 to the acquisition date. We purchased claims-made commercial insurance for acts
 prior to and after the acquisition date. The recorded liability for professional
 liability risks includes an estimate of the liability for claims incurred prior
 to February 1, 2001, but reported after February 1, 2001, and for claims incurred
 after February 1, 2001. As a component of the related liability for professional
 liability risks, we have included the premiums related to the estimated cost of
 insurance for claims incurred, but not reported prior to the acquisition date.




We self-insure
 for workers compensation and employee health risks. The estimated liability
 for workers compensation and employee health risks includes estimates of the
 ultimate costs for both reported claims and claims incurred but not reported. We
 accrue an estimate of losses resulting from workers compensation, employee
 health and professional liability claims to the extent they are not covered by insurance.
 These accruals are estimated quarterly based upon historical loss patterns.




We record
 a liability pertaining to pending litigation based on our best estimate of a potential
 loss, if any, or at the minimum end of the range of loss in circumstances where
 the range of loss can be reasonably estimated. Because of uncertainties surrounding
 the nature of litigation and the ultimate liability to us, if any, we continually
 revise our estimated losses as additional facts become known.




Income
 Taxes  We account for income taxes in accordance with Statement of Financial
 Accounting Standards (SFAS) No. 109, Accounting for Income Taxes.
 SFAS No. 109 requires an asset and liability approach and the recognition of
 deferred tax assets and liabilities for expected future tax consequences. SFAS
 No. 109 generally considers all expected future events other than proposed enactments
 of changes in the income tax law or rates. We have provided a valuation allowance
 for all tax assets so that the net tax asset is zero based on our assessment, using
 factors identified in SFAS No. 109, that it is more likely than not that none of
 the net deferred tax asset will be realized through future taxable earnings or implementation
 of tax planning strategies. Currently, the most significant tax asset is a U.S.
 net operating loss carryforward of approximately $6,300, utilization of which is
 subject to limitations imposed by Section 382 of the Internal Revenue Service Code.


Recent Accounting Pronouncements



In August
 2001, the FASB issued SFAS No. 144, Impairment or Disposal of Long-Lived Assets.
 The provisions of this statement provide a single accounting model for the
 impairment or disposal of long-lived assets. As required by SFAS No. 144, the Company
 adopted this new accounting standard on July 1, 2002. During the quarter ended
 September 30, 2002, there was no impact of adopting SFAS No. 144 reflected in the
 Companys financial statements, however the Company continues to review the
 impact of the standard on its long-lived assets, in particular the


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current facility for Mountainside Medical Center in Jasper,
 Georgia where a replacement hospital is currently being constructed.



In June 2002,
 the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal
 Activities. SFAS No. 146 requires the recording of costs associated with exit
 or disposal activities at their fair values when a liability has been incurred.
 Under previous guidance, certain exit costs were accrued upon managements
 commitment to an exit plan, which is generally before an actual liability has been
 incurred. SFAS No. 146 is to be applied prospectively to exit or disposal activities
 initiated after December 31, 2002.


Related Parties



Two directors
 of SunLink are members of two different law firms, each of whom provide services
 to SunLink. We have paid $206 for legal services to these law firms in the
 three months ended September 30, 2002.





ITEM 3. QUANTITATIVE AND QUALITATIVE
 DISCLOSURES ABOUT MARKET RISK



We are exposed
 to interest rate changes, primarily as a result of borrowing under the revolving
 portion of our credit facility. No borrowing was outstanding on the revolving facility
 at September 30, 2002. No action has been taken to cover interest rate market risk,
 and we are not a party to any interest rate market risk management activities.





ITEM 4. EVALUATION OF
 DISCLOSURE CONTROLS AND PROCEDURES



|(a) |  | Evaluation
 of disclosure controls and procedures  Our Chief Executive Officer and our
 Chief Financial Officer, after evaluating the effectiveness of the Companys
 disclosure controls and procedures (as defined in the Securities Exchange
 Act of 1934 Rules 13a-14(c) and 15-d-14(c) as of a date (the Evaluation Date)
 within 90 days before the filing date of this quarterly report, have concluded
 that as of the Evaluation Date, our disclosure controls and procedures were adequate
 and designed to ensure that material information relating to us and our consolidated
 subsidiaries would be made to them by others within those entities.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Changes
 in internal controls  There were no significant changes in our internal controls
 or, to our knowledge, in other factors that could significantly affect our disclosure
 controls and procedures subsequent to the Evaluation Date.                                                                                                                                                                                                                                                                                                                                                                                                                       

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PART II. OTHER INFORMATION




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



|(a) | Exhibits:
|--- | ---------
|   
|    | 10.1    
|    |          
|    | 10.2    
|    |          
|    | 10.3    
|    |          
|    | 10.4    
|    |          
|    | 10.5    
|    |          
|    | 99.1    
|    |          
|    | 99.2    



|(b) | Reports
 on Form 8-K  On October 15, 2002, the Company filed a report on Form 8-K
 reporting Item 5. Other Events. On October 15, 2002, the Company and HM
 Acquisition Corp., a Delaware corporation and wholly owned subsidiary of the Company
(Merger Sub) entered into an Agreement and Plan of Merger with HealthMont, Inc., a
 Tennessee corporation (HealthMont), providing for the merger of HealthMont with
 and into the Merger Sub. | 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | 

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SIGNATURES



Pursuant to
 the requirements of the Securities Exchange Act of 1934, SunLink Health Systems,
 Inc. has duly caused this report to be signed on its behalf by the undersigned thereunto
 duly authorized.




| | SunLink Health
 Systems, Inc.
| | -----------------------------
| |                              
| | By:  /s/ Mark J. Stockslager 
| |                              
| | Mark J. Stockslager          
| | Principal Accounting Officer 

Dated: November 12, 2002

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##### Table of Contents



CERTIFICATION OF CHIEF EXECUTIVE OFFICER
OF SUNLINK HEALTH SYSTEMS, INC.

I, Robert M. Thornton, Jr., President and Chief Executive Officer of
SunLink Health Systems, Inc., certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of SunLink Health
Systems, Inc.                                                                                                                                                                                                                                            
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.                   
|  
|4. |  | The Registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we
have:                                                                                                     



| | a. |  | designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b. |  | evaluated the effectiveness of the Registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date
of the quarterly report (the Evaluation Date); and                                                                                                   
|
| | c. |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.                                                                                                                        



|5. |  | The Registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrants auditors and audit
committee of the Registrants board of directors:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a. |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrants ability to
record, process, summarize and report financial data and have
identified for the Registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b. |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrants
internal controls.                                                                                                                                            

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##### Table of Contents





|6. |  | The Registrants other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |                                                              
| |  | -------------------------------------------------------------
| |  | Date: November 12, 2002                                      
| |  |                                                              
| |  | /s/ Robert M. Thornton, Jr.                                  
| |  |                                                              
| |  | Robert M. Thornton, Jr.
President and Chief Executive Officer

26



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##### Table of Contents



CERTIFICATION OF CHIEF FINANCIAL OFFICER
OF SUNLINK HEALTH SYSTEMS, INC.

I, Joseph T. Morris, Chief Financial Officer of SunLink Health Systems,
Inc., certify that:



|1. |  | I have reviewed this quarterly report on Form 10-Q of SunLink Health
Systems, Inc.                                                                                                                                                                                                                                            
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report.
|  
|3. |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report.                   
|  
|4. |  | The Registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we
have:                                                                                                     



| | a. |  | designed such disclosure controls and procedures to ensure that
material information relating to the Registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared.
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b. |  | evaluated the effectiveness of the Registrants disclosure controls
and procedures as of a date within 90 days prior to the filing date
of the quarterly report (the Evaluation Date); and                                                                                                   
|
| | c. |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date.                                                                                                                        



|5. |  | The Registrants other certifying officers and I have disclosed, based on
our most recent evaluation, to the Registrants auditors and audit
committee of the Registrants board of directors:
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a. |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect the Registrants ability to
record, process, summarize and report financial data and have
identified for the Registrants auditors any material weaknesses in
internal controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b. |  | any fraud, whether or not material, that involves management or
other employees who have a significant role in the Registrants
internal controls.                                                                                                                                            

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|6. |  | The Registrants other certifying officers and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant deficiencies
and material weaknesses.
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  |                                         
| |  | ----------------------------------------
| |  | Date:  November 12, 2002                
| |  |                                         
| |  | /s/ Joseph T. Morris                    
| |  |                                         
| |  | Joseph T. Morris
Chief Financial Officer

28